Hedge funds: we'll block Branson's Rock rescue

Immovable objectors: Jon Wood of SRM and Philip Richards of RAB want compensation of 400p a share under nationalisation

The biggest shareholders in Northern Rock are threatening to block a rescue package from Sir Richard Branson - and force nationalisation.

SRM Global and RAB Capital, the hedge funds which together own 19.68% of the bank, are said to be ready to oppose the bid from Virgin Group when it is put to a shareholder vote.

Virgin is offering investors a heavily diluted stake through a rights issue at 25p a share. SRM boss Jon Wood has taken legal advice and believes the Government must pay shareholders 400p a share, the book value of the bank, if it is nationalised, at a cost of £1.6 billion.

"We currently oppose the Virgin plan," said a source. "If it were a two-way competition between Virgin and nationalisation, we would vote for nationalisation."

The bank's shares rose 1p to 97¼p today. It is highly unlikely the Government would agree to compensate shareholders to the tune of 400p a share, but ministers may be prepared to compromise to avoid a protracted battle in the courts.

Such an outcome would be a blow to Gordon Brown and his Chancellor Alistair Darling, who support the Branson offer and have seen their reputations trashed by the debacle.

But it would be a victory for the major shareholders who stand to lose hundreds of millions of pounds if their high-stakes game of poker fails.

Shareholders claim any private takeover of Northern Rock requires 75% shareholder support. Virgin and the Government insist it is 50%.

Both SRM and RAB, run by Philip Richards, favour a rival proposal from the bank's management team led by Paul Thompson. The hedge funds have been building their stakes - SRM to 11.5% on Wednesday and RAB to 8.18% last night - and need only a little extra support to reach the 25% they claim could block the Virgin bid.

"It is almost inconceivable that the Government will get the 75% they need," said a source close to the talks.

Legal & General Investment Management, the third-largest holder with 4.79%, also favours the in-house offer.

The Government has told Virgin it is front-runner but must improve its offer to succeed. It is pushing Branson to pay a fee of £200 million if Virgin manages to turn the bank around within three years. The money would be in return for the use of its guarantee of the Bank of England's loan of £25 billion.

Wood and SRM were today sending a report to the Treasury claiming the Bank loan is not state aid and does not break European laws.

The Government is trying to show Brussels it is getting a good deal for taxpayers and is not breaching any rules.